The fiscal illusion has gone – but what has replaced it?

December 17 promised to be the day when the Office for National Statistics finally dispelled the fiscal illusions surrounding student loans that have been flattering the deficit.

And the headlines have certainly promised as much, with most media outlets leading on a £12 billion addition to the figure that records the difference between government income and government expenditure.

But on closer inspection, it has become clear that the method by which that (avowedly indicative) multi-billion sum was reached does not tally with that proposed by the ONS. And much of the complexity of what the ONS is now proposing is still to be fleshed out over the next six months. If Augar’s review panel was waiting on some clarity, it may have to wait a while yet.

Some history

Less than eleven months ago, the ONS provided a written statement to the Economic Affairs Committee. The Lords and Ladies had asked whether student loans could be recorded differently in the national accounts. Along with the members of the Treasury Committee, the members were concerned about how loss-making loans appeared to generate a surplus for government by claiming interest accruing as income even though it was likely to written off.

In reply they received the following:

In the opinion of ONS, student loans meet the definition of loans in the National Accounts … There are no doubt other creative ways … by which student loans could be recorded. However, it should be reiterated that ONS is firmly of the view that the economic nature of student loans closely matches the definition of a loan in National Accounts and should be recorded as such in both the National Accounts and the UK fiscal aggregates.

Cut to December and ONS has concluded that student loans do not “fully comply with the … definition of a loan being an (i) unconditional debt (ii)repaid at maturity” and has exercised its creativity in producing the outlines of a new treatment, variously known as “Option 3” –  “Hybrid” or “Partitioning”.

How this change of heart occurred can be told in abbreviated fashion. The EAC also wrote to Eurostat, the European Commission body responsible for statistics, and received a very different reply a few weeks later. Eurostat pointed out that where significant losses were anticipated then it was not appropriate to use the standard treatment of loans as “financial transactions”. It was later realised that (i) since student loans are income contingent, the debt is not “unconditional”, and (ii) since it is the government’s policy to write off loans thirty years after repayments first fall due, then it cannot really be said that the debt is to be “repaid at maturity”. Far from being robust (as former ministers used to claim) the decision to equate student loans with commercial loans was seen to be badly flawed. Legally, student loans are loans – but statistically, they are not.

The preliminaries to a full-blown review commenced in March, the review was announced in April, and several options were outlined in July (accompanied by a report from the Office for Budgetary Responsibility providing some assessments of the potential impacts on the public finances). In November we heard that a change was coming, but that it was going to be complicated and might take until the end of 2019 to implement.

The ONS announcement

Now we have a brief explanation of the principles behind partitioning student loan outlay into a loan element (“lending”) and a grant or transfer element (“spending”), which has the effect of bringing forward the current end-of-term write-offs to the year of issue. The ONS insists that in future, the accounting treatment for loans will better match economic reality:

government revenue will no longer include interest accrued that will never be paid; and government expenditure related to cancellation of student loans will be accounted for in the periods that loans are issued rather than at maturity.

This led to the dramatic headline implication: the Office for Budgetary Responsibility had estimated that if implemented today, the new treatment would add £12billion to the deficit –  increasing it by 50%. The additional annual sum would then rise to £17bn in 2023/24, when the headline fiscal figure would be nearly doubled on current projections. This impact could be broken down into two components: recording the estimated write-offs on loans issued this year today instead of thirty years hence, and reducing the amount of income bookable from the interest accruing on all existing loans.

The Financial Times emphasised that such a change would have implications beyond higher education:

… if the Treasury does not change its fiscal rule to keep borrowing below 2 percent of national income in 2020-21, the government will lose £14.4bn of its £15.4bn margin for error in its fiscal rule in 2020-21 … .

As such, a change to the treatment of student loans in the national accounts promised to undercut a key plank of the government’s presentation of its claimed fiscal competence.

Of course, the actual economic cost of loans has not changed, only how and when those costs are declared as spending. And this basic observation should be accompanied by a second – the ONS announcement only outlines the general approach that will be adopted. An ONS spokesperson told me:

The estimates are only indicative and are derived using simplified methodology. While they do give an indication of how accounting for one cohort will look like under the new approach, we would advise against using the exact values in the spreadsheets to infer the precise impact on the fiscal aggregates. … While we are clear on the conceptual approach, some practical implications, particularly the mechanisms by which the modelled estimates will be updated, are still under development.

Split difference

Not only do we not have an explanation of the method by which loans will be partitioned, but it is clear that the ONS’s approach to determining the split between lending and spending (roughly 50:50) is not the same as that modelled by the OBR back in July (40:60 in favour of spending). Although every media outlet followed the ONS’s lead by citing the OBR’s £12billion figure, further clarification was forthcoming from the latter:

… the 61% [spending] quoted by OBR relates to total cancellations (of interest and principal) as a percentage of total lending (interest and principal). This approach is somewhat different to our own … The OBR description suggests they have followed a simpler methodology of accruing interest, which we are not following in our example. Of course, any estimates, both from OBR and ONS, are only provisional at this stage.

So, while the general approach has been agreed with Eurostat and ‘much of the wider international statistical community’, quite how it will play out in practice is still very unclear. £12billion may be a good ballpark figure for overall deficit impact, but we will need to wait for June 2019 for proper “provisional estimates of the fiscal impacts”. The split between lending and spending will also determine how the deficit impact breaks down. As already noted, some of that £12billion is due to lower interest accruing and some due to increased expenditure today. For the OBR, roughly one-third of the change relates to reduced income, but the ONS will have a different division.

How that split plays out has implications – as does whatever method is adopted for revising forecasts and reconciling actuals. This new method will be much more complicated than what we currently have (where transactions are recorded when they happen and no estimates are needed). At this stage, it seems clear that initial “partitioning” will be subject to regular review – the process may see parts of each year’s loans moved back and forth between the two categories as assumptions shift and repayments arrive.

Revise and resubmit?

It is disappointing not to have a more fully developed proposal – and the lack of explanation as to why other approaches were rejected is also a problem. I am sure that the Augar review panel would have preferred more definitive answers and will be reluctant to wait until July for the official provisional estimates. But perhaps the obvious question can already be answered – what are the implications for higher education in England? (Note that this ONS decision is UK-wide, affecting all loans).

To reiterate – the cost of loans hasn’t changed, only how they are presented in the national accounts. Unfortunately we have a government ruled by targetry. Since Osborne, the Conservatives have pushed a political narrative with a central place given to the fiscal mandate. As the Chancellor declared at October’s Budget, “Both our fiscal rules met; both of them three years early. So, Mr Deputy Speaker, Fiscal Phil says: Fiscal Rules OK.” These revisions mean that not only has the main target not been met three years early, it’s at risk of being missed entirely. Perhaps tellingly, the official DfE response to the ONS announcement stressed how it had no effect on the headline measure of debt:

Our balanced approach is getting debt falling while supporting our public services, keeping taxes low, and investing in Britain’s future.

Will they choose a new deficit target? Or will they revise the current one once the ONS has performed the onerous task next year of restating recent annual deficits? We could see a sanguine approach. But recall that the Augar review terms of reference state that any new proposals must be consistent with deficit reduction.

Ironically, although Theresa May’s decision to increase the repayment threshold last October made the loan scheme more expensive, it was consistent with deficit reduction at the time. With the accounting change, that’s no longer the case. Both the Institute for Fiscal Studies and London Economics estimated that her snap decision cost £2bn plus per cohort with all of it now upfront expense.

The future

Decisions subsequently taken about loans can move the proposed partition both ways. Issuing fewer loans would likely improve the deficit as a greater proportion of a lower outlay would be covered by repayments. Reducing tuition fees would have a similar effect. And any effort to improve repayments would now manifest itself relatively quickly, though it is hard to see the current government reversing May’s decision regarding the threshold.

There has been a lot of talk of grants. Were the ONS to adopt the OBR’s current method for determining where the partition lies, then replacing loans with grants on a like for like basis will always require more expense. But it is not beyond the realms of possibility that a more sophisticated approach could eliminate a lot of the difference. ONS’s own cohort example shows a 100% spending entry for years 5 and 6. Regardless of technical niceties, it is certainly the case that the “costed manifesto” produced by Labour for the 2017 general election would become easier to assemble in future, as fewer counterbalancing measures would be required to cover the cost of replacing tuition fees with institutional grants.

Less interest in the future

Proposals to abolish interest or reduce it to inflation-only may now have more traction since proportionately less income would be removed than before, but it would still be a measure to increase the deficit.

Politically, loans will become more unpopular and in the short run that is probably going to mean less money going into HE. It is also undoubtedly the case that there is going to be examination of those institutions where graduate earnings are not so strong.

The Commons Treasury Committee welcomed the decision. Nicky Morgan MP, Chair of the Treasury Committee, said:

As the Treasury Committee concluded in its report on student loans, the current accounting rules allow the Government to spend billions of pounds of public money without any negative impact on its deficit target at all.

Today’s announcement from the ONS, which will improve transparency of the public finances, is welcome. Ensuring that Government spending is properly recorded allows it to be properly scrutinised.

Is this the right note to strike? Opportunist arguments for keeping the old way of doing things have some truth. An accounting wheeze made it more likely on balance that the government would treat universities more generously (or less harshly).

I have reservations about the complexity of the new way of doing things, and the lack of detail. I also preferred a different option, one that would not have involved such a violent (and complicated) lurch back to clarity. This change might prove to be the occasion for worse to be implemented. In the end, the chief impediment to rational policy remains the Government’s preference for deficit targetry – and that is harder to dispel.